Can performance-based education bonds improve preschool education?

Could Goldman Sachs help pay for public preschools? Minnesota is considering an experiment with social-impact bonds similar to one Salt Lake City is already trying. Here, math coach Bryan Street works with a pre-K student in 2015 at South Shore School in South Seattle, Washington. Mike SiegelThe Seattle Times

Could Goldman Sachs help pay for public preschools? Minnesota is considering an experiment with social-impact bonds similar to one Salt Lake City is already trying. Here, math coach Bryan Street works with a pre-K student in 2015 at South Shore School in South Seattle, Washington. Mike SiegelThe Seattle Times

Minnesota plans to join Salt Lake City in a novel approach to paying for public education: using “social bonds” to fund early childhood learning.

These bonds raise money in private capital markets, just as bonds for a new power plant or a high school do. What’s unusual is the use of bonds to fund educational or social programs, not buildings or infrastructure.

Funders participate in designing how the social bonds work. The return on the bonds is not a fixed interest rate. Instead, the level of payments over and above return of principal depends on how successful the program is.

Objective performance criteria must be met for there to be any “interest” paid. As with other state and local bonds, all payments to bondholders must come from taxes. The new initiative, with implementation funded by a federal grant, is an interesting test. But it will not solve all ills.

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The difficult economic issue is that there are huge “information problems” in quantifying outcomes of educational or social-service programs. Determining causation with myriad variables is hard. So while there may be advantages to the approach, there are inherent drawbacks.

First, the positives: “Social bonds” are promoted by those convinced that government entities inherently are less efficient in using resources to achieve ends than the private sector.

To the extent that private-sector issuers of a social bond can design and administer the program to solve a specific problem, the prospect of getting a higher reward if performance is good can motivate both innovative initial design and careful day-to-day management. Society gets greater results relative to resources expended.

Another advantage of social bonds is as a new source of funding for public programs that does not require, at least initially, higher taxes. Society can get the benefits of some program — such as better learning by children. But taxes don’t have to be raised to start the program. That money comes from buyers of the bonds.

The bond principal has to be paid eventually, however, and the bond buyers must also get the performance-based compensation specified. This depends on what is achieved relative to measurement criteria.

So money from taxpayers is needed eventually. And, just as a state has to rebuild a certain number of bridges every year, so it will need to fund such educational programs every year. Over the longer run, resorting to bond funding smooths out year-to-year fluctuations, but does not reduce total taxes needed.

Some advocates argue that using the bonds at first will motivate innovation, and any particularly effective new models developed could be adopted for longer-term use by the bureaucracy. There won’t be any patenting of methods. However, to the extent that is true, the smaller are any incentives to attract private capital. If new innovations quickly become a free good, innovating is less motivated.

Also, skeptics say, the extents to which design is constrained by tight regulation and implementation is performed by existing government employees erode incentives for efficiency.

Advocates note that improved educational attainment from the program will have concrete economic benefits in increased productivity. Greater output from a better-educated work force will mean that resources will be available to pay off bonds.

This is true, but if the same increase in educational attainment came from conventional early childhood programs funded through regular school budgets, there similarly would be greater economic output and hence income to pay taxes.

So the crucial question is whether funding through private bonds will motivate design of more effective programs, administered more efficiently, resulting in more productive workers than would come out of a purely taxpayer-funded, government-run public education system. If this does not occur, the exercise is a fiscal shell game.

Deciding on exact performance criteria is a problem. It is harder to determine if and why students are performing better in subsequent years than to determine why a certain fraction of metal stampings fail quality control. If you are going to reward good performance, you need to be able to measure performance in light of many mitigating factors. That is not easy.

Over decades we have spent hundreds of billions of dollars on educational and social programs, the effects of which could not be measured well if we even tried. The incomes of the few public employees who design and run traditional programs depend little on how effective their work was. So the status quo isn’t necessarily better.

Goldman Sachs is putting up some money for the initial bonds. Mere mention of that name makes some on the left see a nefarious mechanism to wrest exorbitant profits from the plight of disadvantaged children. This is paranoia. At this point it is much more likely to represent a do-gooding corporate social responsibility effort than the opening of a lucrative new market.

The fact that philanthropies like the Pritzker Foundation are needed shows Wall Street does not yet see a big profit opportunity.

We should welcome the new initiative with open minds. It is an opportunity to try something that may prove valuable. Don’t expect miracles.

St. Paul economist and writer Edward Lotterman can be reached at boise@edlotterman.com.